Question

A study has been conducted to determine if one of the departments in Parry Company should be discontinued. The contribution margin in the department is $50,000 per year. Fixed expenses charged to the department are $65,000 per year. It is estimated that $40,000 of these fixed expenses could be eliminated if the department is discontinued. These data indicate that if the department is discontinued, the company's overall net operating income would:

decrease by $25,000 per year
increase by $25,000 per year
decrease by $10,000 per year
increase by $10,000 per year

Answer 1

The correct answer is increases by $10,000 per year

Step-by-step explanation:

Given:

contribution margin in the department= $50,000 per year

Fixed expenses charged to the department = $65,000 per year

Now,

Current net income = Contribution - Fixed expenses

or

Current net income = $50000 - $65000 = -$15000 (negative sign depicts loss)

Also,

Fixed cost = $65000 - $40000 = $25,000

Thus,

If this department is discontinued, the loss of $15000 would be eliminated.

but the fixed cost will be there

The net operating income would decrease by

= $25000 - $15000

= $10,000

Hence, the correct answer is increases by $10,000 per year